Sunday, March 8, 2009

Fractional Reserve Banking... not anymore...

On a very related note to the inflation post earlier, the M1 multiplier has dropped below one. This basically means that for every dollar you put in a bank, the bank holds onto more than one dollar (possible because the bank presumably has its own money, and also has received money from the Federal Government in stabilization funds). The number is currently $1.21.

Before this crisis began, GS lent about about 95% of the money it received in deposits, and even the more conservative consumer banks lent out 80-90%.

This is generally accepted as a very bad thing - it means credit is not available for people who need it, which means the economy can't easily restart.

It also means that when banks start lending again, inflation shoots up. The decline in the M1 multiplier is the causal effect of increasing the money supply so much (see prior post) and the increase in credit defaults.

Still, it does mean the financial crisis is in full bore. The post I wrote earlier with no commentary (the letter to Krugman) seems more attractive.